Risks Building for Energy MLPs

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Few business sectors have benefited from ultra-low interest rates and a soaring stock market as much as master limited partnerships — publicly traded energy companies that supply the pipelines, storage tanks and other infrastructure around oil and gas production. MLPS are attracting equity capital like no other industry. Twelve billion dollars flowed into funds that invest in MLPs last year, and an additional $8.8 billion was raised in 21 initial public offerings, largely because MLPs offer high returns, according to a Bloomberg story. (Here’s a Bloomberg graphic on their growth.) Tax exempt, by law they have to pass through most of their earnings to investors.

But MLPs could be headed for some rough times, especially if fickle retail investors, who own about 65 percent of MLPs, decide to invest their money elsewhere and energy produced from shale assets starts to slow. Because MLPs can’t plow back their earnings into capital investment they rely on borrowing and selling shares to grow. “Wall Street banks love MLPs because they earn fees on the transactions,” says Bloomberg. In the past year, bank fees for MLP deals totaled $890.3 million, the news service found.

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“Growth attained by issuing debt and equity becomes a problem if the companies lose investors confidence,” Bloomberg quoted Douglas Johnston, managing partner at Quantalysis LLC, as saying. He called it a gimmick: “retail investors bid the product up. MLPs can then issue more equity to fund the distribution and growth. It works until it doesn’t work.”

For example, MLP Boardwalk Pipeline Partners LP got a loud wake-up call in February. It cut its payout to investors because of declining income, and its stock dropped by almost half.

Among other problem, the nonstandard financial metrics used by MLPs has “caught the attention of the U.S. Securities and Exchange Commission,” says Bloomberg, and some MLPs are expanding from the pipeline business into markets “that may pose [new] dangers for investors” — in particular, drilling, oil refining and shipping.